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Study finds ‘speed bumps’ help protect ordinary investors

By Cezary PodkulThe Wall Street Journal

Thu., June 14, 2018

Stock markets should take a break. Literally.

That is the message in a paper published on Wednesday by an economist at the Securities and Exchange Commission who concluded that a brief delay in stock trading would protect ordinary investors from high-frequency traders.

Upstart exchange IEX slows down trading with a so-called speed bump that pauses inbound orders for 350 microseconds before relaying them to its exchange for execution. (Chris Goodney / Bloomberg News File Photo)

The finding broadly endorses the business model of IEX Group Inc., an upstart exchange that slows down trading with a so-called speed bump that pauses inbound orders for 350 microseconds before relaying them to its exchange for execution. IEX also delays outbound updates to its market data feed.

When it sought SEC approval to become an exchange in 2015, IEX said the delay would prevent rapid-fire traders from racing ahead of typical investors and unfairly profiting off the speed advantage. That claim was disputed by high-tech market maker Citadel, which warned the SEC that allowing speed bumps would “increase transaction costs for all investors.”

In June 2016, the SEC granted IEX’s application to become an exchange and since then others have also begun to experiment with trading delays, including the New York Stock Exchange and the Chicago Stock Exchange.

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While the study doesn’t officially resolve the issue of trading delays — it represents the view of one agency economist, Edwin Hu, not the SEC itself or its commissioners — its findings could encourage the regulator to approve more alternative exchange models like IEX’s speed bump.

Mr. Hu studied the universe of U.S.-listed stocks and compared those that traded most frequently on IEX against those that had limited executions on the exchange — and thus didn’t benefit as much from its speed bump. He found a decrease in trading cost for the frequently-traded stocks, equivalent to about 20 to 50 cents for every 100 shares traded.

“The evidence seems to be consistent with IEX’s speed bump resulting in improved market quality for some stocks,” Mr. Hu said in an interview.

An SEC spokeswoman declined to comment. A spokesman for Citadel didn’t immediately respond to a request for comment.

IEX cheered the report’s findings.

“This clearly contradicts the ‘doom-and-gloom’ predictions,” said John Ramsay, IEX’s chief market policy officer. “It’s good to have independent verification of the healthy effect that we have had on the trading system”

Other factors could explain why trading costs declined over the period that Mr. Hu examined, including the fact that stock prices were going up. Stock prices are a part of the ratio for calculating trading costs, and as they rise, that ratio would fall, said Robert Battalio, a finance professor at the University of Notre Dame.

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“It’s an interesting study, but there are other factors that need to be ruled out,” Mr. Battalio said.

Mr. Hu’s research found that IEX’s launch as an exchange didn’t change the quality and reliability of prices across the fragmented stock market. The exchange still accounts for a small portion of overall stock market volume — about 2.5 per cent, according to a spokesman.

Mr. Hu’s study likely isn’t the last word from the SEC on the issue. To allow IEX to use its speed bump, the SEC in June 2016 reinterpreted one of its rules to allow for intentional trading delays. At the time, the agency said it would conduct a separate study to measure the impact of such delays.

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